US Labor Dept. to allow ESG considerations for retirement plan investment advisors

The US Department of Labor (DOL) announced on 10 March that it will not enforce two rules written by the Trump administration that would restrict retirement plan advisors from considering corporate environmental, social and governance (ESG) as a risk factor when making investments.

DOL is not rescinding the rules, but said it will "revisit" them. Until it publishes further guidance, it will not enforce any alleged violations of the rules.

In making the decision to suspend enforcement, DOL said it re-reviewed comments from asset managers, labor organizations, consumer groups, service providers, and investment advisors. Commenters raised the question of "whether these two final rules properly reflect the scope of fiduciaries' duties under ERISA to act prudently and solely in the interest of plan participants and beneficiaries," DOL said.

ERISA, the Employee Retirement Income Security Act of 1974, governs how investment advisors manage and select investments for pensions and funds available to be selected in a 401(k) or 403(b) plan.

President Joe Biden ordered the Labor Department to review both rules as part of an executive order on his first day in office, 20 January 2021, "Executive order protecting public health and the environment and restoring science to tackle the climate crisis." The order required the government to review all federal rules that the prior administration issued between 20 January 2017 and 20 January 2021.

When the "Financial Factors in Selecting Plan Investments" rule was proposed last year, stakeholders submitted more than 8,700 comments. The rule was published on 13 November 2020, and took effect on 12 January 2021, though with a phase-in into 2022.

The second rule, "Fiduciary Duties Regarding Proxy Voting and Shareholder Rights," was published in the Federal Register on 16 December, and it went into effect on 16 January 2021.

ERISA

Under ERISA, investment advisors have a fiduciary duty to manage the investments "solely in the interest" and "for the exclusive purpose" of providing benefits to participants and their beneficiaries. ERISA prohibits advisors from using as investment criteria "any non-pecuniary objectives or [to] promote goals unrelated to the financial interests of participants or beneficiaries."

To support the rules that are now not going to be enforced, the prior administration stated that "ESG-type factors" were to be considered non-pecuniary unless the investment advisor could determine that those factors "would have a material financial effect on the investment."

In other words, the burden of proof had shifted from ERISA plan advisors being able to assume that ESG was a reasonable risk factor to the advisors having to back up that assumption.

ESG as investing growth area

IHS Markit reports that investments in ESG funds are growing steadily, adding about $50 billion in 2020 alone to reach $250 billion in the passive investment category. "Clients who want exposure to passive funds and ESG will benefit from the expanding availability of products offering diversified equity index portfolios at low cost," IHS Markit said in a January 2021 report on investing trends.

Two issues that DOL expressed concerns about -- consistency of ESG standards and the "materiality" of those criteria to a company's financial performance -- are high priorities within the cleantech investing space, said IHS Markit. "Convergence and momentum to harmonize standards and seek out a holistic solution to ESG reporting will gain more traction," it said.

Materiality was, IHS Markit said, "the bedrock of a clear and credible ESG and sustainability narrative, together with an explanation of corporate purpose."

The American Retirement Association (ARA) said that one survey conducted in 2020 found that 72% of the US population expressed interest in ESG funds. In a letter to DOL last year to oppose the "Financial Factors" rule, ARA said a growing number of active fund managers (those who select investments rather than mirror broad market indexes) "are recognizing the materiality of ESG factors in evaluating investments."

For renewable energy firms, use of ESG is important for attracting investors, said Gregory Wetstone, president and CEO of the American Council on Renewable Energy. "These Trump-era rules were intentionally designed to override the free market and hamstring ESG investing, one of the nation's most important and fastest-growing finance trends," he said in a statement on 10 March.

"ESG investments consistently outperform the market and are often recognized as the best choice for realizing maximum long-term returns. We are hopeful that Labor officials will soon reverse these misguided policies entirely and instead adopt rules that support and enhance sustainable investments nationwide," Wetstone said.

Review of policy

In writing the "Financial Factors" rule last year, however, DOL expressed concern that investors could be harmed by using ESG factors. Because there is no single definitive definition of ESG, it is prone to "inconsistencies … lack of precision and rigor … [and is] vague and inconsistent."

But to support its new stance on the issue, DOL said that stakeholders said the new rules actually created more confusion. "The department has also heard from stakeholders that the rules, and investor confusion about the rules, have already had a chilling effect on appropriate integration of ESG factors in investment decisions, including in circumstances that the rules can be read to explicitly allow," DOL said.

The department also noted concerns about whether the rules "were rushed unnecessarily." In particular, the "Proxy" rule had been finalized after only a 30-day comment period.

Posted 11 March 2021 by Kevin Adler, Editor, Climate & Sustainability Group, IHS Markit